Loosening the Restrictions on FHA Condo Finance

Congress has thrown its support behind new legislation that aims to fix some of the problems in the condo financing program of the Federal Housing Administration (FHA).

The Housing Opportunity through Modernization Act (H.R. 3700) will loosen some of the more stringent regulatory requirements specific to condo mortgage insurance that were introduced in the wake of the housing finance crisis. The Senate unanimously passed the bill in early August, following a similar unanimous vote by the House of Representatives in February. It was signed into law on July 29.

The FHA will have to modify certain aspects related to its condo mortgage insurance program that have been widely criticized in recent years. Specifically, the legislation affects requirements allowing condo projects to qualify for FHA eligibility as it relates to the recertification process; transfer fees; the percentage of units that need to be occupied by owners; and the amount of commercial space allowed.

“There is a recognition by both the FHA and Congress, given the huge margin that this particular bill passed by, that current FHA policy is too restrictive with respect to condominiums,” says Stockton Williams, executive director of the Terwilliger Center for Housing. Yet it is still uncertain as to how those changes will be received by condo developers and homebuyers, and, ultimately, how the changes might affect the moderately priced and affordable segment of the condo market that relies more on FHA-insured mortgage financing.

The general feeling in the condo industry is that these changes are positive for homebuyers and developers, but are not likely to have a huge impact for two reasons, says Williams. One, a large number of condominium associations left the FHA program after more stringent regulatory requirements were introduced in 2010. According to a recent Washington Post article, fewer than 14,000 of the 152,000 condo associations in the United States are now eligible for FHA loans. “It sounds like these changes were well received by those groups, but bringing them back to the FHA program is going to take some time and effort before it will have a big impact,” he says.

Two, the FHA is in the process of making more changes to its condo program. Those changes are expected to involve reinstating “spot” or individual unit loans, as well as end the blanket prohibitions against community-benefit homeowner transfer fees and allow more commercial space within condo projects, says Williams. Until those additional modifications take effect, what was included in H.R. 3700 will likely have a beneficial but modest impact on the market, he says.

One of the main reasons condo buyers choose FHA loans is that they offer a very high loan-to-value ratio of 97 percent—or a 3 percent downpayment—and also allow homebuyers to roll closing costs into the loan amount. The trade-off for that access to capital is higher fees. The FHA is not making the loan, but rather insuring the loan, and borrowers have to pay for that insurance as an upfront cost and as a monthly mortgage insurance cost.

The impact may be muted initially on new condo development by the fact that most of the new projects being built include units priced high enough that the FHA financing is not helpful, says James Gaines, chief economist of housing markets and housing development at the Texas A&M Real Estate Center in College Station, Texas. “This may be one of those things where the premise that ‘FHA is going to help condo ownership’ sounds good, but the end result is that it is not going to have that much impact on sparking new, moderately priced condo development,” says Gaines. “Where [FHA-insured loans] are going to have the most impact is on the existing condo market where the older properties tend to have a little bit lower prices.”

Lenders like FirstBank Florida, a $12.5 billion regional community bank based in Miami, have pulled back on financing residential construction projects since the end of the financial crisis of the late 2000s. “However, we are very active in facilitating and offering the end loans for consumers that are buying condominiums in projects,” says Calixto Garcia-Velez, executive vice president of FirstBank.

“There is no question that, depending on what gets passed by Congress and what ends up being the final modifications to the program, it will significantly impact how banks look at condo financing,” says Garcia-Velez. The reason for that is that, in middle-income and low-income projects, banks very much count on the assistance of the conforming mortgage product in order to facilitate the purchase of the condo by individual families, he adds.

In theory, improving liquidity may provide an incentive to encourage more affordable condo development projects. “It would stand to reason that improved liquidity through the FHA program will help,” says Williams. However, there are other barriers to a better-functioning housing market for middle-income people, including the higher cost of development, he adds.

Prior to the housing crisis, the FHA insured about 80,000 to 90,000 condo mortgages a year. However, that volume has declined to about 20,000 units per year, according to the Washington Post. Clearly, the FHA has been and could again be an important part of financing for condominiums. “Whether these changes in the bill in and of themselves are enough to restore that is unclear, but these changes with what the industry expects the regulatory changes the FHA will make some time later in the fall, should have together a pretty significant positive effect,” says Williams.

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